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You're probably familiar 
with one or more banks 
in your neighborhood. 



Perhaps you or someone in 

your family has a checking 

or savings account at a 

local bank,,. 

... or perhaps someone in 

your family has recently 

taken out a loan ai a bank — 

to buy a car. for example. 

...tiut il does perform a variety of 

task; to help the U.S. economy 

function smoothly and meet 

Che nation's economic goals. 

The Fed is best known for its handling of monetary policy. 

which consists of influencing money and credit conditions in the 

econoniy in order to help the U.S. economy experience strong 

growth in output and income, high employment, and stable prices. 

The job of making monetary 
policy often is a balancing 

act, as the Fed has to make 
sure that money and credit 

don't grow either too slowly 
or too rapidly. 

I'm afraid you won't be 

able to buy the car. Interest 

rates are way up because there's 

not much money to lend, and the 

monthly payments at the higher rates 

are more than you can afford. 

I know you would like to expand 

your factory, but because we don't 

have much money to lend, we have to 

charge a high interest rate. You wouldn't 

be able to afford the monthly payments. 

n 'w^ouR^^zn 

So to try to prevent both recessions and inflation, the Fed has three main monetary 
policy tools: open market operations, reserve requiremenLs, and the discount rate. 







Open market operations are 
purchases and sales by the Fed of 
U.S. government securities, which 

are large lOUs of the (ederal 

government. When the Fed buys 

securities, it pays for them by 

crediting the amount of the 

purchase to the account that 

the seller's banl< has at the Fed. 

The bank, in turn, credits the 

setter's account. 

Thus, open market purchases by 

the Fed provide the banking system 

vjilh additional funds to lend. 

In that way, open 
market purchases 
tend to lower the 
federal funds rate, 
the interest rate 
that banks charge 
each other on very 
short -term loans. 









A drop in the federal funds rate can 

lead to a decline in the rates that banks 

charge on loans and pay on deposits. 

-°^- ' 



The opposite occurs when the 

Fed S'Mis government securities, 

jn unusual occurence. 


The Fed collect? payment for the 

securities by subtracting the amount 

of the sale from the account that 

the buyer's bank has ai the Fed. 

The bank, in turn, subtracts 

the amount from the buyer's 

account. Banks row have less 

to lend, the federal funds rate 

may rise, and some borrowing 

may be discouraged. 


That means 

people may 

buy fewer cars 

and businesses 

may buy less 

new equipment. 

, Rather, the Fed deals with about twenty 
. large firms - brokers and broker -dealers 
- that buy and sell government securities 
and can handle the large purchases and 
sales efficiently, quickly, and safely. 



Indeed, the Fed's 

□pen market operations 

are conducted 

electronically in a 

matter of minutes. 

When the Fed decides to change its 
monetary policy, it uses open market 
o-perations to implement the change. 


However, most of ihe Fed's open market operations 
have nothing to do with changes in monetary policy. 


The Fed conducts open market operations several times a weel< 

in order to prevent technical, temporary forces from pushing 

money and credit conditions in some undestred direction. 

One of these forces is the amount of cash in circulation. 

The amount of cash that people have 

with them is not constant. It varies 

seasonally, by day of the month, and 

even by day of the week. 


For eiaiiiij.e jiujii'- 
use a Lol ul cash in bi iy 
[ shopping seasons. 




4 -i 




Also, over the weekend, people use ATMs 

to withdraw a lot of cash from banks 

for shopping and entertainment. 

I guess I m not the only 

one who thought there'd be no line 

at the ATM because everyone would 

spending the day watching the 

pro football games. 


Reserve requirements are another, 

though far less frequently used, 

tool of rnonetary policy. Reserve 

requirements are the percentages 

of certain deposits that banlts must 

have either in their own vaults 

or on deposit at the Fed. 

For example, if the reserve 
requirement is 10S, a bank 
that receives a S100 deposit 
must have S1 in its vault or 
at its Federal Reserve Bank. 

As the process continues, the banking system will expand an initisl $100 deposit into as much 
as SI, 000 of deposits. These deposits are considered pail of liie nation's money supply. 


= $1,000 

By law, the Fed can set the reserve requirement on checking accounts 

anywhere from 85& to 1^*. If the requirement were 14%, rattler than 10^, 

the bank that received the S100 deposit would keep SKon reserve 

and lend a maximum of SB6, rather than 590... 

J?« »x 

... and the next bank would be able to Lend 
just 86% of $86. or S7i.'*, rather than S81 . 

With a I'^'i'i leserve rf?quirenient, the banking system would be flble 
to expand the initial SlOO deposit into )ust S7M. rather than S1 ,000. 

$100+$86+$J3.96+$63.61+ ... + ... = $7^4 

So, reserve requirements 

are a powerful tool, as 

they affect the abihty of 

J the banking system to create 

1 money. However, the Fed 

rarely changes reserve 


9% • 



Since cutting the reserve 

requirement on checking 

accounts from M% to 10% in 

April 1992, the Fed has not 

changed the requirement. 

/^"""^ ~^ 


^^ ^^- ,^ ^^- ^^ ,# ^^ / / / / / ^^- 

Also, when the Fed has to reduce the growth of 

money and credit, it would rather not do so by raising 

reserve requirements, because the requirements 

impose a kind of tax or cost on banks. 

Still another tool of monetary policy involves the 

discount rate, the Interest rate that the Fed charges 

banks on short-term loans. Changes in the discount 

rate can influence other interest rates. 


However, the Fed often implemerHs changes in 
monetary policy without changing the discount rate. 

J i S l^j^ 



- - - } - — f— -i^ — |- r-+ — iJ— ->■ ■ - 

--1— 1— »— 



For example, between 

mid-1995 and the end of 

1998, the Fed changed its 

target for tlie federal 

funds rate on seven 

occasions, but on only 

three of those occasions 

did it change the 

discount rate. 

The discount rale 
refers to a primary credit 

rate on loans to 

the financially strongest 

banks and a higher 

secondary credit rate 

on loans to oiher banks. 

The Federal Reserve also affects the U.S. economy when it intervenes for the U.S. monetary 

authorities the Treasury Department and the Fed - in the foreign exchange markets, in which 

dollars are exchanged for foreign currencies such as the Japanese yen and the euro. 

The foreign exchange (FX) value of the dollar is growing in 

importance as international trade and finance expand. 

Exports, for example, now account for almost 12^ of the output 

of the U.S. economy, up from less than 5% in the early '60s. 

The FX value of the dollar can affect the 
economy in a number of ways. If the dollar 
appreciates (rises in value), foreigners have 
to pay more in their currencies to buy U.S. 
goods. The higher effective price, in turn, 
could lead foreigners to buy fewer U.S. goods, 
causing some U.S. companies to lose profits. 


On the other hand, if the FX value of the 

dollar falls (that is, the dollar depreciates 

U.S. consumers have to pay more for 

foreign-made goods, and that could help 

cause inflation in the United States. 


On occasion, the U.S. Treasury 
Department and the Fed decide 
to Intervene in the FX market. 

These interventions are small compared 
with the total amount of FX trading, so 
they don't influence supply and demand 

conditions in the currency market. Rather, 
they influence market sentiment relating 

to the foreign exchange value of the dollar. 

So far, we've seen that the Fed has various ways to foster a healthy 

economic climate. The Fed also provides banks with services that 

help the economy function smoothly. Some of these activities 

make it easier for people to make payments. For instance, the 

Fed provides banks with cash to meet their customers needs. 

On the other hand, when banks 

have more cash than they need, 

they ship the excess to the Fed 

for credit to their accounts. 

TTie Fed uses high-speed machines 

to count the bills that the banks deposit. 

These state-of-the-art machines also 

check the denomination of each bill. 

The machines also spot 
possible counterfeit bills... 

pot ■ 
ills... I 

...and identify bills thai are worn and not fit for 

continued use. Another machine shreds those bills 

which are then disposed of at landfills. 



3 C 

While cash is iisen fof some transactions in the economy, checks are used for many others, 
and the Fed pronessfs about one-third of all the checks written in the United States. 

Suppose you live in California and 
you send a check to a company in 
New York to pay for some clothing. 

The company in New Vori- v^ 11 

deposit the check in its bank, 

which will credit the amount of the 

check to the company's account. 

In many cases, the bank will then 

send the check to the Federal 

Reserve Bank of New York, which 

will credit the amount to the 

account that the bank has at 

the New York Fed. 


The New York Fed will then send the check to the Federal Reserve Bank of San Francisco, which will subtract the 

amount of the check from the account that your bank has at the San Francisco Fed, and then send the check to 

your bank, which will subtract the amount from your account. 

New York Fed 

San Francisco Fed 


- 50 


While cash or checks are used 
for most transactions, the dollar 
volume of electronic payments 
is much larger than that of 
checks and cash combined. 

The Fed also pjuvide-i 

loans to banks under 

certain circumstances. 

F Banks typicaily borrow 
from private sources. Out 
may come to Federa 
Reserve Banks when private 
funding is not available or 
temporarily too co^nv. 

Since 2003, the interest rate v^tiich banks pay when they borrow from the Fed has been higher than the 
federal funds rate, the interest rate at which banks with extra reserves lend to banks that need the reserves. 

I don't have enough 
f reserves to meet my 
Vreserve requirement. 

As of 2003, banks are permitted to borrow from 
the Fed at the primary or secondary credit rate 
and then turn around and lend to other banks. 

However, smce the primary and secondary credit rates 

are higher than the federal funds rate, opportunities 

to make profitable loans to banks are few. 


The Fed has a special lending program, 

seasonal credit, for banks that face severe 

seasonal pressures each year - at certain 

times of the year, the banks have only 

limited deposits and they face a large 

demand for loans. 


Under the seasonal credit program, 

banks can borrow for up to nine months 

each year. Most of the banks that use this 

program are in agricultural communities. 




The Fed also performs financial 
services for the U.S. governmeni. 

■ /'^ Just like """^ A" 
I^B f everyone else, 1 need \ \ 
^M \ a bank account to / * 
H^^S.^^^^ pay my bills. / ^ 




w ^^>^ 

't ' — \4H £i 1 













Thus, people who get federal income tax refunds, 
whether by check or by electronic payment, receive 
the payments from a government account at the Fed. 

The farmers have to 

borrow now to plant their 

crops, and they won't tie sending 

us many deposits until they harvest 

the crops. We may have to ask the 

Fed to give us a loan until then. 

The government didn't 

have to sent) you a check. 

Your tax refund was deposited 

I your account electronically. 



Now, debt or lOUs that the federal govern ment issues exist only 

as electronic records, individuals may put these electronic 

securities in Legacy Treasury Direct accounts, 


/>iOw you wont have to worry 
' that your Treasury securities 
might be destroyed In a fire, 
and you won't even need a safe 
deposit box to store them. 
They're perfectly safe as 
-electronic securities. 

Another responsibility of the Federal Reserve 

(one that it shares with some other government 

agencies) is to supervise banl<s in order to 

make sure they operate safely and soundly, 

and are sensitive to risks. 

For example. Fed bank examiners look at banks' financial 

statements to make sure that the banlts have enough capital 

{funds of their own) to withstand risks from a downturn in 

the economy or unpaid loans. 

The Fed also examines banks' operating procedures 

to make sure that they are not too susceptible 
to theft or fraud by their employees or by others. 

J I'll change the 
password right now, and 
t won't give anyone the 
new password. 

When the Fed finds a problem in the way a 

bank operates, it often can be resolved without 

penalty or any other supervisory action. 



In more serious cases, the Fed can fine 

banks and individuals, and in the most 

entreme cases, it can even close a bank 


Another' law enforced by the Fed is the 

r.iir Credit and Charge Card Disclosure Act, 

Ahich says that appUcations for credit cards 

mjst tell you wliether you have to pay an 

annual fee for the card and what interest 

rate you have to pay on the balance in 

your account. 

tm. 1 

To get this credit card, yoi 

have to pay a $20 fee each yea'. 

On the other hand, the interest rate 

^.□n this card is lov/er than what somi; 

of the other cards chiirge 



We've looked at many of the 
activities that the Federal 
Reserve performs. Let's look 
now at tlie different parts of 
the Federal Reserve System 
and what each part does. 

The System is headed by 

the Board of Governors. 

I which is in Washington, D.C. 

The Board of Governors consists of seven members, appointed 

by the U.S. president and confirmed by the U.S. Senate. 

Governors are appointed to Myear terms. 



These- terms are much longer than those of the president, 

ii^'n.ilors, or members of" the House of Representatives. 

^^S^ \V 

^ I 

Also, the 14-year terms are staggered. That means they don't all expire at 

the same time. One term expires every two years. The staggered M-year 

terms reduce the influence of politics on the Fed, 

If all the Feds governors 

complete their terms, I'll be ablel 

to appoint only two governors 

in my four-year term. 


Another factor ttiat 

promotes the Fed's pohtical 

independence is that the 

Fed does not have to 

reiy on appropriations 

from Congress. 

The Fed Is financially self-sufficient. 

Its income comes predominantly 

from interest it receives on its holdings 

of U.S. government securities. 

Not only is the Fed financially 

self-sufficient, but it actually takes 

in much more income each year 

than it spends. The Fed returns to 

the U.S. Treasury the excess of what 

it takes in over what it spends. 

Of course, the Fed's 

independence is far from 

total. By law, the chairman 

of the Federal Reserve has 

to testify tiefore Congress at 

least twice a year regarding 

the Fed's monetarv policy. 

Also, it was Congress that created 

the Fed. The U.S. Constitution gives 

Congress the power to coin and 

regulate the value of money, and 

Congress has decided to delegate 

that authority to the Fed, At times. 

Congress has changed the Fed's powers. 



For example, in 1980, Congress 

passed a law saying that all banks 

in the United States have to meet 

the Fed's reserve requirements. 

Until then, only banks that 

belonged to the Federal Reserve 

System had to meet them. 

If alt banks have to 

meet the Fed's reserve 

requirements, the Fed will 

^be able to do a better job of J 

influencing money and 

credit conditions. 

» », 


In any case, the Fed is more 

independent than other parts 

of the government. 

Interestingly, other countries have taken steps in recent years 
to increase the political independence of their central banks. 






That's because independence helps a central bank focus on 

long-term economic problems. Indeed, research shows that countries 

with more central bank Independence tend to be more successful 

in controlling inflation than other countries. 


In addition to the Board of Governors, 

the Fed consists of 12 Federal Reserve 

Banks spread around the country. The 

Reserve Banks provide financial services 

for the U.S. government, supervise banks 

in their districts, and provide banks with 

services, such as the provision and storage 

of cash, loans, and check processing. 

This map shows the location of the Reserve Banks and the district 
that each one serves. As shown on the map, the Reserve Banks are 

concentrated in the eastern half of the United States. That's because 
when the Fed was created, U.S. population, business and financial 

activities were far more concentrated in the east than they are now. 


'New Yorh 
Board of 


("""" — -5 O U.S. Vli^ln 

Puerto Rleo t-^^^ 


Both the Board of Governors and the Reserve Banks play a 

role in the monetary policy process. The Board of Governors 

sets reserve requirements. 

Each Resetve Banl< sets its primary and secondary credit rates 

every two weeks, subject to the approval of the Board of 

Governors. (Because the United States has a national credit 

marltet, the discount rate, and now the primary and secondary 

credit rates have, for many decades, been uniform throughout 

the Federal Reserve System.) 

Meanwhile, monetary policy is 

determined by a group called the 

Federal Open Market Committee (FOMC), 

which meets in Washington, D.C., 

eight times a year. 

The meetings are attended by the 

members of the Board of Governors 

and the presidents of alt 12 Reserve 

Banks. There are only 12 voting 

members, however -the seven governors 

and five of the Reserve Bank presidents. 

^^^ York 

There are several reasons why the president of the New York Fed is a 
permanent voting member of the FOMC. One is that the New York Fed 

oiiriLnts M the open rnark'.--'. operations for the Federal Reserve System 

In addition, when the U.S. monetary 

authorities intervene in the foreign 

exchange market, the intervention is 

carried out by the New York Fed, 

The Federal Reserve Bank of New York also provides a 
variety of service; to foreign central banks. 


For example, the New York Fed stores tjillions of dollars' worth of gold 

for foreign central banks. The gold makes a dramatic sight, and the 

Federal Reserve Bank of New York invites visitors to see it. 

(Indeed, each year, more that 25,000 visitors do just that.) 

Fewer than half the banks in the 
country —about 33%- are members 

of the Federal Reserve System. 
However, they tend to be the larger 
banks, and they have about eighty 

percent of all U.S. bank deposits. 


The member banks choose six members of the board of directors 
of their local Reserve Bank, and the Board of Governors chooses the 
three other directors, including the chairman and deputy chairman. 



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Bank of New York's education programs 

can be found at: 

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Public Information Department 

33 Liberty Street 

NewYork, NY 10045